- One of the main factors driving this divergence will be the different rate of COVID-19 vaccine rollouts. China and India are ahead in Asia, having administered 40.5 and 11.9 million doses respectively (3% and 1% of the population). In contrast, most Asian developed markets lag their emerging market peers or have yet to announce comprehensive vaccine plans. The only exception is Singapore, where 4.5% of the population has already been vaccinated.
- Philippines, Thailand and Malaysia are more exposed to cyclical upside risk in terms of domestic consumption and tourism. Thailand, South Korea and Vietnam stand to gain the most from better demand from the US and China.
- The pace of US yield curve steepening will dictate the direction of portfolio flows going forwards. On the plus side, the USD is expected to remain weak in either case, which will be supportive of Asian asset classes.
Brighter growth prospects in 2021 on vaccine hopes
According to our forecasts, Asia is projected to lead the global economic recovery in 2021. On a GDP-weighted basis, the region is expected to expand by 6.6% this year, up from -1.0% in 2020. Excluding China, Asia will expand at a slower rate of 4.7% in 2021, up from -4.3% in 2020. In terms of regional disparities, India will expand at 9.0% in 2021, the fastest pace in Asia and significantly above the -8.0% contraction in 2020. On the flip side, Japan will be the least dynamic market in Asia, expanding by 2.5% in 2021 versus a -4.8% contraction in 2020.
One of the main factors driving this divergence will be the different rate of COVID-19 vaccine rollouts. Excluding China, India is ahead of the pack in Asia in terms of vaccine deployment. The government has committed USD 5 billion to the world’s biggest vaccination campaign, aiming to immunise about 300 million people in the coming months.
India approved the use of AstraZeneca’s vaccine and the Covaxin (developed by local firm Bharat Biotech). Both are manufactured domestically and over 11 million doses have been administered since the beginning of the year, second only to China. In the case of China, the approval of its domestic Sinovac shot started earlier in 2020, and the health authorities have already administered 41 million doses. Bangladesh and Indonesia trailed India, with 2.7 and 2.0 million administered doses. Bangladesh is using India’s Covaxin shot, while Indonesia has procured China’s Sinovac shot and is currently conducting stage-3 clinical trials. Philippines has approved three shots, including Sinovac, Pfizer and AstraZeneca. However, the rollout of its inoculation scheme is delayed as European manufacturers seek indemnification clauses in their sales agreement with Manila. In contrast, developed markets (DMs) in Asia lag their Emerging Market (EMs) peers. Excluding Singapore, where 4.5% of the population has already been vaccinated, most Asian DMs have yet to announce comprehensive schemes, falling behind both in terms of the total number of administered doses, as well as doses per 100 people. That said, most Asian markets are still behind the UK and the US where 28/100 and 20/100 people respectively have already received COVID-19 vaccines.
The pace of recovery will also depend on the extent to which the economies are exposed to cyclical upside pressures.
Countries where final consumption expenditure accounts for a larger share of GDP should stand to benefit the most from a normalisation of economic activity. Moreover, global vaccine rollouts will also benefit a gradual recovery of the transport sector, reducing cyclical headwinds for economies in Asia that have a high dependency on tourism revenues as a share of GDP. According to figures by the World Bank, the economies in Asia most exposed in terms of these two indicators are: Philippines (88.5%), Thailand (79.1%), Australia (77.8%) and Malaysia (77.6%).
Fiscal authorities take over for the next leg of recovery
Most central banks in the region underwent aggressive rate cut cycles in 2020, more so than during the Global Financial Crisis (GFC) in 2009. However, following Bank Indonesia’s interest rate cut on February 18, the rate cut cycle in Asia has now mostly come to an end. Going forwards, central banks in the region will remain wary of higher inflation expectations and a steepening of the UST yield curve. Together, both factors will likely result in a compression of real rate differentials with the United States (US). Real rate differentials are calculated by taking the difference between the 10Y notes after adjusting these or inflation. As a result of narrowing differentials, investors looking to deploy cash for carry may find Asian government bonds less enticing relative to the second half of 2020, thereby reducing the potential for additional capital inflows. Despite Consumer Price Inflation (CPI) remaining subdued in January 2021, we expect that most economies in Asia will experience higher inflation in 2021 on the back of base effects that will kick-in starting in April. This excludes China and India, where deflationary pressures may persist due to disruptions to local food supply chains last year (African Swine Fever in China and poor monsoon rains in India). CPI numbers will increase gradually in Asia as we head into Q2- 21, albeit the increase will be weaker than in other parts of the world. As a result, central banks will have less space to continue stimulating the economy via traditional means.
Instead, fiscal authorities will take over from central banks for the next leg of the recovery. Discrepancies between DMs and EMs are also noteworthy here. Throughout 2020, major DMs in the region (including Australia, Hong Kong, Japan, Singapore and South Korea) have announced COVID-19 support packages exceeding 30% of GDP, according to figures compiled by the International Monetary Fund’s (IMF) COVID-19 Policy Response Tracker.
Despite EMs in the region passing fiscal bills, these have been smaller in magnitude relative to their DM peers (around 10% of GDP on average). Going forward, all Asian markets are expected to announce expansionary budgets for the upcoming financial year through to March 2022 (FY-22), albeit the size of the budgets amongst EMs in the region will remain smaller compared to DMs.
In the short run, this will mean less cyclical upside for EMs relative to their DM peers. However, it may leave Asia’s emerging economies better-off in the long run, particularly in cases where fiscal stimulus is accompanied by an ambitious reform agenda. A great example of this is India’s bigger-than-expected budget for FY-22. The budget will focus on measures to boost consumption, but also establish the creation of a USD 2.7 billion infrastructure fund. Better infrastructure will enable India to boost its manufacturing sector in the years to come, attracting a larger share of Foreign Direct Investment (FDI) and unleashing labour productivity. Lower overall fiscal deficits compounded with higher urbanisation rates and young, expanding middle classes, leave Asian EMs overall in a better position to gain on a structural basis. According to estimates by the European Commission, 89% of populations in Asia lived in urban areas, above the world average of 85%. The median age of the ASEAN population today is 28.9 years, more favourable than DMs such as Japan (46.5), Hong Kong (43.2) and even China (36).
Exposure to recovery in the US and China
Lastly, the cyclical recovery will also depend on demand from key export markets such as China and the US. We observed some demand substitution away from Asian markets, towards China in 2020. This was the result of supply chain disruptions in many Asian economies, which endured longer lockdown periods than China. The situation will reverse in 2021, supporting better manufacturing and exports activity. Beyond this base effect, ASEAN became China’s top trading partner in 2020, followed by the European Union and the United States. Going forward, inter-regional trade will continue to provide impetus for growth as China rebalances its economy towards consumption-oriented growth. For both reasons mentioned above, activity could pick up more significantly in economies that are embedded in both China and the US’s supply chains. Combining exports to the US and China as a percentage of GDP, we find that the economies that stand to gain the most are: Thailand (26%), South Korea (20%) and Vietnam (19%).
Beyond these cyclical factors, Asian EMs will also benefit from longer-term structural trends like supply-chain shifts out of China. The pandemic highlighted some of the limitations associated with overdependence on one market and supply chain concentration. China also wishes to diversify away from basic manufacturing, towards high value-added manufacturing, something that is expected to be enshrined as part of its upcoming five-year plan. Given existing supply chain linkages, relatively low labour costs and favourable demographics, we believe that Asian EMs will likely benefit the most. The structural shift will result in higher FDIs – both from Chinese companies and global companies – into the manufacturing sector, which should continue to industrial upgrading and higher potential growth in many of these economies.
Implications for investors
A strengthening cyclical recovery and prospects of higher earnings will continue to support inflows into Asian markets in the short term.
However, these will remain contingent upon the pace of the US yield curve steepening. In case the latter exceeds expectations, it is possible that global investors will redeploy capital towards USTs, which could result in fewer inflows into Asian EMs.
On the fixed income front, brightening growth prospects will also be supportive of Asian debt in places where the riskreward balance remains favourable, even in case the US economy gathers steam more rapidly than expected. Equity valuations are high but remain more attractively priced relative to their global peers. The MSCI Asia is trading at 17x earnings (vs 21x for MSCI World) and remains 11% below its 2018 peak. Lastly, despite seeing the yield curve steepening in the US, the USD remains weak and we do not expect substantial appreciatory risks in 2021. This will likely continue to be supportive of Asian asset classes.